Chapter 10. The Securities and Exchange Commission

For a while, everyone was enjoying a tremendous bull market. Business seemed to be booming. Investors were excessively speculating in the stock markets, optimism was very high, and some people were even pondering early retirement. Then, all of a sudden, quite dramatically, all of it changed. Large corporations began going bankrupt. Corporate officers were found to be deceiving the public. Executives became engaged in courtroom battles that grabbed the nation's headlines. As a result, investors became leery of corporations and the stock market plummeted.

While this may sound like 2002, we are actually describing the way things were during the late 1920s and early 1930s. This period spawned the Great Depression. There are many examples of fraudulent behavior that can be used to illustrate the condition of those times, including unethical activities by corporate executives, securities analysts, large investors, and even newspaper reporters (who hyped their own stocks). Instead of dwelling on such examples, we simply point out that our nation has been in a similar situation before. That is, it has experienced a crisis in investor confidence. In a revealing comment in 1932, Charles Schwab of U.S. Steel stated, "I don't know, we don't know, whether values we have are going to be real next month or not." ^[1] Does this comment seem vaguely familiar?

What did the United States do to try to fix the crisis during the early 1930s? It did something quite dramatic. It decided to federally regulate the securities markets, and it also created the SEC. The SEC would become an advocate for investors by putting them on equal footing with the corporations in which they invested, and it would become a type of corporate police force. In fact, the SEC was created specifically to restore investor confidence. When President Franklin D. Roosevelt signed the Securities Act of 1933 into law, he stated, "The Act is thus intended to correct some of the evils which have been so glaringly revealed in the private exploitation of the public's money." Seventy years later, why are we again in the midst of an investor confidence crisis? Was the creation of the SEC not the solution that we were looking for? Was the SEC caught off-guard? Is the SEC partly to blame for the crisis today?

It is important to point out that U.S. corporations are regulated by many governmental agencies. For example, the Fair Trade Commission (FTC) regulates advertising by businesses, and the Food and Drug Administration (FDA) approves drugs for sales by pharmaceutical companies ”all of which is done for the protection of consumers. What makes the SEC different from other business overseers (thus making it the focus of this chapter) is that it is assigned the role of protecting investors.

Interestingly enough, in the wake of recent corporate scandals, the SEC is not being criticized too badly . In the summer of 2002, there were some who called for the resignation of Harvey Pitt; at the time, he was the SEC chairman appointed by President Bush. Those demands were mostly based on the fact that Pitt was once one of the top attorneys representing the accounting profession. At one time or another, as a lawyer for the firm Fried Frank Harris Shriver & Jacobsen, Pitt had represented all of the Big 5 accounting firms. Thus, some felt that he had a conflict of interest. After all, how will he be expected to be critical of those individuals and companies that he once protected? In addition, there are also others, mostly Democrats, who are skeptical of Pitt's desire for more regulation. Due to the role of the SEC chairman in government and business, it often becomes a political lightning rod.

For the most part, however, investors feel that the SEC was fooled along with everyone else. Even though no one is pointing fingers at the SEC, it is certainly in the spotlight. There is a call from investors for reform and a tougher regulatory stance. This chapter will provide an overview of the SEC, its role in our business environment, and its potential weaknesses. We will also discuss Pitt's predecessor Arthur Levitt, who many believe tried to warn us that this crisis could happen, and the challenges that had faced Pitt.